Fixed deposits of banks with a maturity of five years or more will only qualify for tax breaks with the government set to issue a notification this week.

An investment of up to Rs 1 lakh in bank term deposits of a medium maturity of five years or more will enable investors to qualify for a tax deduction of up to Rs 1 lakh starting from this fiscal.

Investments in bank deposits will now be eligible for a tax deduction similar to that offered for payment of insurance premia, payment of school tuition fee, repayment of the principal amount on housing loans besides contribution to small savings schemes under Sec 80 C of the Income tax Act.

Although the banking division of the finance ministry had recommended three years as the cut-off eligibility for a tax break in line with the banking industrys demand, the revenue department did not go along with the proposal.

The Central Board of Direct Taxes was of the view that bank deposits could not be equated with the Equity Linked Savings Scheme (ELSS) which has a lower maturity of three years and yet offers tax breaks.

Officials said that there was the element of risk in equity linked schemes compared to bank deposits especially when a large number of banks have the backing of the sovereign.

Tax breaks are being provided for the first time for term deposits considering the difficulties faced by banks in mobilising medium term funds while competing with tax free instruments like small savings schemes.

The government also acceded to the demand of the banking industry this fiscal to provide this tax break after taking into account the blistering growth in credit last fiscal. The new scheme for tax deduction for term deposits is expected to address the issue of premature withdrawals.

In all the other schemes like the Public Provident Fund and the National Savings Certificate which offer a similar tax deduction, there is a lock-in.

Earlier, banks used to cite the advantage of flexibility in withdrawals before maturity compared to small savings schemes for term deposits even though it came with a penalty in some cases. Now with a tax benefit on offer, that flexibility will go.